Sunday, May 31, 2015

The New York Times has an article this morning describing the turn towards anti-immigration populism in France, inspired by the renaming of the Gaullist opposition party as The Republicans. This is seen as an attempt to attract voters who have gone over to Marine Le Pen’s National Front, an overtly chauvinist party with a semi-fascist past. The article points to the rise of similar movements in other countries; most worrying is Finland, a country in which the extreme right has played a major political role at key times during the past century, and where a nativist party is now part of the governing coalition.

The irony is that the nativists themselves, in order to expand, have had to move to the left on economic issues. This has been widely noticed with the National Front, whose base was once small entrepreneurs. Nativistis now claim to be the staunchest defenders of the welfare state and the interests of the working class. The steady erosion of social protections and living standards, they say, can be halted only by ending immigration, especially from the “incorrigible” populations of the Middle East and North Africa—i.e. Muslims. The name change in France makes a subtle play for this attitude by claiming the anti-clerical mantle of the French Revolution, now seen as a weapon against the influence of Islam. Yet it also implies a leftward orientation on social and economic matters, since Republicanism has historically meant identification with the goals of the Revolution, as against the conservative, clerical and aristocratic opposition. It perfectly captures the current moment: embracing the nativist Right while pretending to be more Left on other matters.

Meanwhile, the real Right can be found in the halls of power in every major European country. This Right is socially liberal but against exactly the things the populists are trying to preserve: equality, improvement in living standards and generous social protection. The political isolation of Greece within the eurozone, for instance, demonstrates how rentier ideology has completely triumphed over Keynesian and social democratic perspectives throughout the continent. The ostensible socialists are as much a part of this conservative coalition as the official conservatives.

Is it any surprise, under these circumstances, that nativism has taken wing? A large part of the European working class has concluded that scarcity and stagnation are permanent, and that the promises of the Left can’t be trusted any more. All that remains is the politics of exclusion, making sure you have yours by locking the others out. So high unemployment is the new normal? Then the jobs belong to us. Can’t afford the welfare state any more? Send immigrants from poor countries back home. On a gut level it makes perfect sense.

If there is a future for cosmopolitanism in Europe, it needs a credible politics of growth and redistribution.

The Sandwichman has been out of town since last Wednesday and the Financial Times (those FT monkeys) has seized the opportunity to publish not one but two articles foisting the farcical lump of labour fallacy fable on an unsuspecting public. This is evidence of a complete lack of journalistic ethics. A simple fact check would reveal that the fallacy claim is bogus.

Tuesday, May 26, 2015

In the conclusion to their 1941 article "Protection and Real Wages," Wolfgang Stolper and Paul Samuelson wrote:

...it has been shown that the harm which free trade inflicts upon- one factor of production is necessarily less than the gain to the other. Hence, it is always possible to bribe the suffering factor by subsidy or other redistributive devices so as to leave all factors better off as a result of trade.

This is an instance of the infamous Kaldor-Hicks compensation criterion, which David Ellerman has shown to be a "same yardstick" fallacy. Ironically, Ellerman took the same yardstick analogy from another paper by Samuelson and elsewhere Samuelson is dismissive of the Kaldor-Hicks criterion.

Ian Little described the K-H criterion as unacceptable nonsense. But, hey, let's fast-track the TPP and maybe one of those winners will toss us a bribe!

My bottom line on the economy is: The fundamentals are sound. The underlying momentum in job growth remains solid. I expect wage growth to continue to rise and consumer confidence to continue to pick up steam. Monetary policy will remain highly accommodative—regardless of what may or may not happen with rates this year—which will spur spending. -- John C. Williams

As Sandwichman always says, when they're telling you "the fundamentals are sound," they are unloading.

The Left’s favorite economist of the moment, Thomas Piketty, organizes his argument in Capital in the Twenty-First Century around the statement r > g, where r is the rate of return on capital and g is the rate of economic growth ... r > g is a stronger argument for privatizing Social Security than it is for a global capital tax.

After telling workers what they put into the Social Security Fund, he jots off this lie:

That money is not invested, so there is no return on it.

The Trust Fund does put these funds into government bonds which earn the real return to government bonds but I interrupted Williamson’s parade of lies:

Professor Piketty estimates that the return on capital over the coming decades will be between 4 percent and 5 percent; historical returns to equity investments run about 7 percent, but let’s be conservative and split Professor Piketty’s estimate, assuming a 4.5 percent return.

So many rates of return, so little insight. What is at stake here? Let’s assume the risk-free real return is 3 percent and add a 4 percent premium if someone chooses to hold risky stocks instead of government bonds. And let’s also assume some worker was able to accumulate $1 million under Williamson’s preferred world of privatization. Even if this worker was able to avoid the bad advice and huge fees from the financial advisors that Williamson is lobbying for, he is likely to get a 5 percent return if he chooses to put half of his portfolio into stocks and the other half into bonds. After all, this worker knows stocks are risky. I sometimes wonder if the champions of privatization do as their writings seem to suggest they don’t get Finance 101. So back to Williamson’s complaint about our current system:

You pay, officially, 6.2 percent of income up to $117,000 a year for Social Security. Your employer pays another 6.2 percent, and many economists and nine out of ten people who were born at night but not last night assume that you really pay that part, too, in the form of lower wages.

In our example suppose that this has taken $400,000 of our worker’s portfolio and put that into government bonds earning 3 percent. Our worker – who we are assuming knows more finance that apparently Williamson does – redoes his portfolio optimization putting $100,000 of his $600,000 into bonds and the rest into stocks. The basic message is that his retirement income is exactly the same. This is basic finance and maybe I’m being unfair. Maybe Williamson knows all of this. If so, then he has chosen to lie to his National Review readers hoping they are this stupid.

Rakesh Vohra of the Game Theory Society reports that not only was John Nash returning from the airport after returning from Norway to receive the Abel Prize in mathematics, its equivalent of the Nobel (the Fields medal is the equivalent of the John Bates Clark award, given for those under 40), which he got for his embedding theorem, which he always viewed as more important than his Nobel prize winning game theory equilibrium, which he considered to be mathematically trivial, despite its wide applicability in economics and other disciplines, but it has only recently been revealed that he had a third major intellectual breakthrough that has only become public since 2012 when the National Security Agency declassified a letter Nash initially wrote in 1950 to its predecessor, the NSA not becoming officially organized until 1952.

In this letter Nash proposed a form of possible encryption used decades later by the NSA based on computational complexity theory, particularly the distinction between P, or polynomial length programs, and NP, or non-deteriministic polynomial (exponential and greater) length programs, relative to the key. While declaring this to be a true distinction, he foresaw the later problem that it might be impossible to prove, and so far it has not been, becoming the greatest unsolved problem of computational complexity theory. Nevertheless Nash used this as the key to hardening encryption code systems, with his thoughts on this far ahead of any of the thinking at that time, although it took those he wrote to a long time to realize it and follow up on his advice.

This makes me understand a bit more a famous incident in 1958 reported in Sylvia Nasar's book, A Beautiful Mind, although it did not turn up in the movie version. A. Adrian Albert, chair of the math department at the University of Chicago, then one of the top in the world, offered Nash a position, with him then in the MIT department. He turned down the offer on the grounds that he was expecting to shortly be appointed "Emperor of Antactica." In fact, this was one of the first signs of his developing mental illness, although at the time Albert dismissed this as mere eccentricity, which many brilliant mathematicians exhibit.

What makes this new report from Vohra interesing in light of this is that this secret letter may have been the key to Albert's invitation. The reason for this was a little known fact even now, that during World War II Adrian Albert was almost certainly the top cryptanalyst in the US, with some of his work remaining classified for decades as well. Under the circumstances, it is highly likely that Albert was one of the few people who was privy to Nash's letter at the time and understood its significance. I have no confirmation of this, but the facts about Albert are fairly clear if one googles him properly, with his role in these matters in the US publicly, but not widely, known (I provide a link to his Wiki entry, which is both sparse and contains at least one mistake). He remains a relatively obscure mathematician, but one , whose importance far outweighs his reputation.

Update: So, there is more about the Albert-Nash link that I have been thinking about, with a further speculation completely unprovable regarding why it was this year that Nash (with Nirenberg) got the Abel Prize. First let me note that Abel's work is closely linked to that of Albert, with Abelian groups being a central focus of Albert's study and linked to the algebraic forms he used in his cryptanalytic (or cryptographic) work. I also suspect that while officially Nash received the prize for his embedding theorem, the revelation of his letter on computational complexity to the NSA (sent in 1955, closer to the year Albert made his job offer to Nash, with that even more evidence that the secret letter was crucial to that rejected job offer), The revelation of this letter may well have provided a tipping point for finally giving the award to Nash, although he had almost certainly been on the list for a long time for the embedding theorem, as he himself considered it his most important work, at least in his public comments, having kept quiet about this letter until its public revelation.

The further wiggle on this is the appearance and success during the past year of the movie about fellow cryptanalyst, Alan Turing, The Imitation Game. Again, I do not know, but my speculation is that this could not have hurt. Both Nash and Turing were the prime subjects of popular movies that depicted both their sufferings and their classified work, although in the movie about Nash it did not show his most serious classified work, but rather depicted it as the central part of his fantasy, and his fantasies did involve matters of international peace and war, with himself both the victim of red-tie wearing communist agents as well as thinking he was an international messianic figure who would achieve world peace between the superpowers. Indeed, the matter of his thinking he would become the Emperor of Antarctica, the ostensible reason he rejected Adrian Albert's job offer, was tied to such fantasies, 1958 being the Internatinal Geophysical Year of Antarctica, when the US and the USSR and 10 other nations signed a treaty to mutually manage Antarctica.

This matter of the letter was not in Sylvia Nasar's book, but he did work for RAND, although probably not on this openly, with most of his more known work there being on game theory, with him becoming upset there by the Dresher-Flood experiments on the repeated prisoner's dilemma showing agents not using the Nash equilibrium but cooperating a lot in the experiments, including even the very rationalistic, Armen Alchian. This upset him so much that it would lead him to abandon game theory work, leaving the naming of the prisoner's dilemma game to his major professor, the late Albert W. Tucker. But, in the end , the more fantastical version in the movie may have been closer to reality, with his close link to the also suffering and highly secret Alan Turing possibly a key to his eventual receipt of this prestigious award, clearly the culmination of his life. It was indeed "going out at the top" that happened in this particular case of a husband-wife death, for better or worse (with their schizophrenic son, Johnny, the clear victim of this situation)..

Further update: The error that I am aware of in Adrian Albert's Wiki entry is the claim that in 1961-62, he was the first director of the Communications Research Division of the Institute for Defense Analysis, located in John von Neumann Hall on the Princeton campus, an NSA front research group. He was the second such director, not the first. (One can find a discussion of Princeton's IDA/CRD unit, no longer on the campus, in James Bamford's seminal book on the NSA, The Puzzle Palace.)
Barkley Rosser

Further Update, 5/38/16: I thank Dan Weber and "Jake," commenters on Marginal Revolution for noting errors in my original post, with Dan catching the especially elementary (and egregious) one that polynomial length programs are "P," not "N," duh. I have corrected the text to fix the points raised (Jake's were more esoteric but valid about the nature of NP).

Monday, May 25, 2015

The mathematical price of demonstrating that every game had a fixed value was the unloading of all analytical ambiguity onto the very definition of the game. Far from being daunted at a game without determinate bounds, Nash was already quite prepared to relinquish any fetters upon the a priori specification of the structure of the game, given that the entire action was already confined within the consciousness of the isolated strategic thinker. The game becomes whatever you think it is. He dispensed with dummies, exiled the automata, and rendered the opponent superfluous. This was solipsism with a vengeance.

Yanis Varoufakis, "The Dance of the Meta-Axioms":

In game theory itself, questions were raised about the plausibility of presuming that rational agents must always select behaviour consistent with Nash’s (1951) equilibrium. In the context of static games it became apparent that disequilibrium behaviour could be fully rationalised and rendered consistent with infinite order common knowledge rationality. Similarly, it transpired that out-of-equilibrium behaviour could be just as rational in finite dynamic games as the equilibrium path proposed by Nash and his disciples. As for indefinite horizon games, the devastating force of indeterminacy was felt in the form of the so-called Folk Theorem which shows that, in interactions that last for an unspecified period, anything goes. And yet, all applications of game theory, from theories of Central Bank behaviour to industrial organisation, labour economics and voting models, ignore these challenges, assuming that behaviour will remain on the equilibrium path.

Nash’s lecture, “Ideal Money and Asymptotically Ideal Money,” centered on the connection between fluctuation in inflation and exchange rates and the perceived long-term value of money. “Good money,” he argued, is money that is expected to maintain its value over time. “Bad money” is expected to lose value over time, as under conditions of inflation … Nash argued that the emphasis on stabilizing the value of currency should extend to the international level, where exchange rates represent currencies’ value relative to each other. He proposed that international exchange rates be fixed by pegging the value of each currency to a standardized basket of commodities, called the “industrial consumption price index.” Such a policy would curtail the ability of central banks to make monetary policy…After World War II, international exchange rates were fixed, with currencies’ value first pegged to gold and later fixed at set ratios. That regime was abandoned in the early 1970s, when increasing inflation forced the United States to devalue the dollar. Nash said his system would be more stable and sustainable than the gold standard because exchange rates would not be seriously affected by fluctuations in any one commodity….Nash responded with caution to the suggestion from an audience member that a system of currencies approaching perfect stability would ultimately produce a system with only one world currency. “There’s nothing wrong with it,” Nash said. But he added, “In practice, I’m a little distrustful of the politicians at the level of the United Nations and elsewhere,” who would be in charge of administering a world currency.

Nash’s lecture was in 2005. While the U.S. did endure the Great Inflation but from 1983 to 2007, we enjoyed the Great Moderation without pegging the dollar to any basket of commodities. But let’s also consider the case of Italy and the EU experiment with a common currency. Over the 26 year period where the Italian lire was free to devalue, Italy’ consumer price index rose by more than a factor of 11, which translates into an average inflation rate of 9.7 percent per year. Since 1999, Italy’s average inflation rate has been only 2 percent. In 2005, things seems to be working well. Of course, we know that the EU experiment has been a disaster during the Great Recession as noted by Barry Eichengreen and Peter Temin:

We describe in this essay why the gold standard and the euro are extreme forms of fixed exchange rates, and how these policies had their most potent effects in the worst peaceful economic periods in modern times. While we are lucky to have avoided another catastrophe like the Great Depression in 2008-9, mainly by virtue of policy makers' aggressive use of monetary and fiscal stimuli, the world economy still is experiencing many difficulties. As in the Great Depression, this second round of problems stems from the prevalence of fixed exchange rates. Fixed exchange rates facilitate business and communication in good times but intensify problems when times are bad.

The Rules of the Game brings together essays, written over the course of thirty years, by a major figure in the field that analyze and compare a wide variety of important international monetary regimes. These range from the establishment of the gold standard in the nineteenth century through Bretton Woods, the dollar standard, floating exchange rates, the European Monetary System, to current proposals for reforming world monetary arrangements.

Nash contributed immensely to game theory but I’m not sure he revisited the issue of international monetary regimes in light of the Great Recession.

...all the difficulties and rigidities which go into modern Keynesian income analysis have been shunted aside. It is not my contention that these problems don’t exist, nor that they are of no significance in the long run... Robert M. Solow, "A Contribution to the Theory of Economic Growth," 1956.

...the shunting aside opened up the opportunity for real-business-cycle theorists such as Finn Kydland and Prescott to use Solow’s steady-state model... for their explanation of short-run fluctuations. Harald Hagemann, "Solow's 1956 Contribution in the Context of the Harrod-Domar Model," 2009.

Far too much has been shunted aside.

The aim of Harrod's and Domar's models, according to Hageman, was "to extend Keynes's analysis into the long run by considering under what conditions a growing economy could realize full-capacity utilization and full employment." As for "the modern type of dynamic [that is, 'growth'] theory," according to Sir Roy Harrod, Keynes "hadn't got round to it":

Mr. Nicholas Dimsdale: Why is there so little in the General Theory on the direction of principal determinants of economic growth (which has, of course, been very much the concern of economic policy in the post-war period), and particularly did Keynes see this as a natural extension of handling the problems of unemployment?

Sir Roy Harrod: I think the answer is no. I think of the timetable of it. Here was Keynes giving all his brains to the General Theory which is not, though it is what you call macroeconomics, dynamic. It is a general theory of how incomes and employment are determined at a given point of time. Then, poor man, he gets ill, the war breaks out, he writes this little booklet of which Austin Robinson has spoken just now, and he is entirely immersed in the war. You see, the use of growth as a regular economic concept had hardly come in before the war: it has all blossomed among various writers since the war. I don’t see how Keynes can have been expected to have systematic ideas on growth; his systematic ideas related to full employment. The modern type of dynamic theory about what happens through time - he just hadn't got round to it. I am sure that he would have got round to and dealt with it very well; but the timetable of his life and death did not give him an opportunity.

In a 1965 New York Times retrospective on the Keynesian "revolution," John Kenneth Galbraith credited Leon Keyserling as a "tireless exponent of the [Keynesian] ideas. And he saw at an early stage the importance of enlarging them to embrace not only the prevention of depression but the maintenance of an adequate rate of economic expansion." In a subsequent interview, Keyserling was less bashful about the magnitude of his contribution.

Coming over to economic growth in particular, everybody talks about the influence of Keynesian economics. The Keynesian economics is really a static economics. It doesn't deal with economic growth at all. Furthermore, it was developed at a time of worldwide depression. Even Ken Galbraith, in an article in the New York Times a couple of years ago, when he was talking about the influence of Keynesian economics, mentioned me specifically as the one who had introduced the fundamental new factor of the dynamics of economic growth.

Keyserling was a member of President Truman's Council of Economic Advisers, became acting chairman in 1949.and chairman in 1950. His influence can be seen in the evolution of "economic growth" in successive volumes of the Economic Report of the President. In the January 1947 annual report, the term "growth" did not occur. In the midyear report, "economic growth" appeared once. The January 1948 volume contained 17 references directly to economic growth and featured a cheerleading section titled "Our Ability to Grow."

All of this alleged "extending" and "enlarging" of Keynes's analysis had little to do with Keynes's analysis -- other than shunting it aside -- and nothing to do with Keynes's own views about the long term problem, as outlined in his 1943 Treasury memorandum, "The Long-Term Problem of Full Employment" and re-iterated in a 1945 letter to T.S. Eliot:

Not long ago I was at a Conference where the Australians urged that all the Powers in the world should sign an international compact in which each undertook to maintain full employment in their own country. I objected on the ground that this was promising to be 'not only good but clever'. Civis, like the Australians, takes exactly the opposite line. He thinks that we can reach the goal by promising to be 'not so much clever as good '.

It may turn out, I suppose, that vested interests and personal selfishness may stand in the way. But the main task is producing first the intellectual conviction and then intellectually to devise the means. Insufficiency of cleverness, not of goodness, is the main trouble. And even resistance to change as such may have many motives besides selfishness.

That is the first, ought-to-be-obvious, not-very-fundamental point. Next the full employment policy by means of investment is only one particular application of an intellectual theorem. You can produce the result just as well by consuming more or working less. Personally I regard the investment policy as first aid . In U.S. it almost certainly will not do the trick. Less work is the ultimate solution (a 35 hour week in U.S. would do the trick now). How you mix up the three ingredients of a cure is a matter of taste and experience, i.e. of morals and knowledge.

It would be anachronistic to fault growth theorist for ignoring Keynes views on the long term problem of full employment. Presumably, Keynes's memorandum and his letter to T.S. Eliot were not available to early "dynamic" theorists. They were published in 1980 in volume 27 of Keynes's Collected Writings. One might wonder, though, why modern growth theorists have subsequently shown no interest whatsoever in re-evaluating their theories in light of those documents.

More remarkable is the complete lack of connection between growth theory and growth as a policy slogan. No, this is not the difference between map and territory. The theoretical models are maps of an abstract territory in which some kinds of features have the same names as the kinds of features on the actual territory -- "labor", "income", "output," "capacity utilization" -- but those labels remain undefined in any way that would correspond to the real features with the same name.

At the other end of the theory/sloganeering spectrum -- in the targeting of increases in GNP/GDP -- the features are also not defined in a way that would enable a consistent and durable system of measurement. Simon Kuznets's 1947 essay on "Measurement of Economic Growth" outlined many of the biases and obstacles in the way of defining and measuring growth." In a subsequent review of the Commerce Department\s National Income and Product Accounts, Kuznets argued that problems of duplication and of ignoring non-market production had not been overcome. In its reply to Kuznets, the department's economists pointed out it would not have been feasible to meet several of his standards. They had a point. But non-feasibility of the alternative does not in itself affirm the adequacy of the status quo.

In conclusion, Keynes's analysis was not "extended" by modern dynamic growth theory nor was it "enlarged" by Leon Keyserling's siphoning off and his sloganeering growthmanship. The analysis was -- in Solow's apt phrase -- shunted aside for a tautological model, just as the policy goal of full employment was shunted aside for the indistinct slogan of "growth."

Who needs a Keynesian policy goal of full employment anyway when the neoclassical model can simply assume full employment?

Sunday, May 24, 2015

Is formatting what it all comes down to? Let's keep the message upbeat, familiar and comfortable. A little bonding around a well-liked celebrity (or against a disliked one) and a platitude or two. Above all, NO NEGATIVITY! Keep it light, superficial and unthreatening.

Will anything change in the wake of the big mathiness dustup of 2015? Of course not. This is, after all, only a "technical discussion on cavalry tactics at the Battle of Austerlitz" not a searching inquiry into the identity and fundamental commitments of the economics political economy.

In his 1872 review of Thomas Brassey's Work and Wages, Frederic Harrison denounced political economy as a "magazine of untruth," specifying, "Political economy professes to be a science based on observation. But the bitter pedantry which often usurps that name usually assumes its facts, after it has rounded off dogmas to suit its clients."

Today's growth economics assumes the same facts and rounds off the same dogmas as did its magazine-of-untruth counterpart 143 years ago. Up until the 1870s, that dogma was called the wages-fund doctrine. Since the 1950s, it has borne the alias of economic growth. Same difference. The affiliated "fact" is that all blessings flow from the expansion of trade, therefore any impediment to that expansion is anathema.

Friday, May 22, 2015

...the characteristics of the special case assumed by the classical theory happen not to be those of the economic society which we actually live, with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience. -- JMK, GT

The human perception system sees a checkerboard with a cylinder, while a basic SSR measurement [surface spectral reflectance] shows squares A and B read the same. “Illusion” implies that our system is fooled, but as far as useful information goes, the checkerboard interpretation is probably better. Try as they might, mathematicians can’t make the computers see the checkerboard. Rather than a demonstration of how easily fooled we are, optical illusions like this one are examples of the brain’s mysterious and irreplicable abilities. It interprets its environment with a sophistication that exceeds our ability to measure and reconstruct physical phenomena. The usual framing has it wrong: Despite A and B having the same SSR, humans are still able to see the checkerboard. -- Malcolm Harris, "Does color even exist?"

How you mix up the three ingredients of a cure is a matter of taste and experience, i.e. of morals and knowledge. -- JMK, Letter to T.S. Eliot

There are powerful domestic and international economic forces and welfare state policy impacts—-such as the huge increase in Social Security disability and food stamp recipients—– that are roiling labor force participation rates and weakening labor hours utilized and labor productivity. Yet the Fed is led by a clueless, paint-by-the-numbers Keynesian “conomist” who is trapped in a 1960s “full-employment” time warp. Did she notice this over the last several decades?

So Stockman refers to Janet Yellen as a conomist. Cute! Why did Reagan appoint a historian to head the OMB anyway? Of course those were the days when supply side hacks ruled the White House. But FYI Mr. Stockman – Dr. Yellen is excellent at labor economics. The drop in the employment to population ratio since 2007 has been the result of weak aggregate demand not some alleged change in transfer payment policies that did not happen. Yes, transfer payments rise when we have recessions as they did in 1982. But if Stockman had an ounce of integrity, he might have told his readers that the employment to population ratio for women start rising even before Reagan made the mistake of letting Stockman head the OMB. With more women in the work force, some men have decided to take up more of the responsibility of raising the kids. I guess Stockman wants to return to the 1950’s where women just stayed home – barefoot and pregnant.

Thursday, May 21, 2015

Jeb’s father in 1980 got it right with his phrase “voodoo economics”. Of course Papa Bush had to settle for being Reagan’s Vice President. We know George Jr. listened to the Three Stooges (Art Laffer, Lawrence Kudlow, and Stephen Moore). Daniel Strauss reports:

Former Florida Gov. Jeb Bush (R) voiced support for House Republicans' move to switch to a type of budget scoring that assumes tax cuts create economic growth and counterbalance lost revenue. Speaking in New Hampshire on Thursday, Bush was asked about House Republicans' move to adopt the "dynamic scoring" method for scoring budgets. Although critics argue that this approach to scoring is essentially "fairy dust" and "cooks the books" on budget scoring, many Republicans and even a few conservative Democrats have pushed for using the controversial method. In December of last year, House Republicans opted to not reappoint Doug Elmendorf as the head of the nonpartisan Congressional Budget Office, essentially paving the way to adopt dynamic scoring. At the beginning of 2016, House GOPers passed a rule requiring all budgets to use dynamic scoring in budget estimates. Bush first said he was "all in" for eliminating the "bean counters" who use the traditional "static scoring" method. "The House has done this and I think it's the right thing," Bush said in New Hampshire on Thursday. He went on to praise House Ways and Means Committee Chairman Paul Ryan (R-WI), who, in Sept 2014, actually floated the idea that the CBO adopt dynamic scoring. "One of the guys I most respect in Washington D.C. is Paul Ryan. He's thoughtful, he's optimistic, he believes that if you create the right conditions all of us interacting amongst ourselves will create far more benefits for far more people," Bush said.

Hey – I’m no fan of bean counters but could someone tell Jeb that Paul Ryan’s accounting is fraudulent?

Wednesday, May 20, 2015

I would like to say why I think that the Doomsday Models are bad science and therefore bad guides to public policy. ... The basic assumption is that stocks of things like the world’s natural resources and the waste-disposal capacity of the environment are finite, that the world economy tends to consume the stock at an increasing rate (through the mining of minerals and the production of goods), and that there are no built-in mechanisms by which approaching exhaustion tends to turn off consumption gradually and in advance. You hardly need a giant computer to tell you that a system with those behavior rules is going to bounce off its ceiling and collapse to a low level. -- Robert M. Solow, 1973

Sandwichman is agnostic on the built-in mechanism fable.

On the one hand, Solow's "built-in mechanism" is a metaphor -- a depiction -- and of course there is no "mechanism" strictly speaking, just as God is not an old man with a long, white beard. There are instead more or less spontaneous reflexes of economic actors that in the aggregate have observable effects. Such reflexes, however, are multitude. The probability of all these reflexes co-ordinating themselves spontaneously and independently -- without help from a Maxwellian demon, Walrasian auctioneer or Invisible Hand -- to produce a conjectured effect far in the future is infinitesimal.

Suppose someone sits down where you are sitting right now and announces to me that he is Napoleon Bonaparte. The last thing I want to do with him is to get involved in a technical discussion on cavalry tactics at the Battle of Austerlitz. If I do that, I’m getting tacitly drawn into the game that he is Napoleon Bonaparte. -- Robert M. Solow

Aside from the multiplicity of so-called mechanisms, there is the slight inconvenience that a homeostatic regulator itself consumes energy to do its work (also known as 'transaction costs'). The more vast and complex the organism being regulated, the more energy the regulator will need to consume. When what is being regulated is the consumption of energy, a contradiction emerges: progressively more energy needs to be consumed to reduce the consumption of energy. There is thus a ceiling on vastness and complexity and a floor on reducing consumption.

It is not the finiteness of resource stocks, but the fragility of self organized natural cycles that we have to fear. Unfortunately, the services provided by these cycles are part of the global commons. They are priceless, yet ‘free’. Markets play no role in the allocation of these resources. There is no built-in mechanism to ensure that supply will grow to meet demand. Indeed, there is every chance that the supply of environmental services will dwindle in the coming decades as the demand, generated by population growth and economic growth, grows exponentially. -- Robert U. Ayres, 1998

Ayres highlighted another fly in the built-in mechanism ointment. To be fair, Solow did acknowledge the externality flaw in the price system. Fixing the flaw, he assured, would be simple and virtually painless:

The flaw can be corrected, either by the simple expedient of regulating the discharge of wastes to the environment by direct control or by the slightly more complicated device of charging special prices — user taxes — to those who dispose of wastes in air or water.

What stands between us and a decent environment is not the curse of industrialization, not an unbearable burden of cost, but just the need to organize ourselves consciously to do some simple and knowable things.

Now that we know how that organizing ourselves consciously business has worked out, couldn't we please have a built-in mechanism to do that task too? What if there is a built-in mechanism in the price and profit system that militates against the social capacity "to organize ourselves consciously to do some simple and knowable things"?

Not all built-in mechanisms are equal

Finally, even if there was a built-in self-stabilizing market mechanism, it's interaction with natural systems may not lead to the gradual, advance adjustment that Solow conjectured:

We identify and prove that the interaction between a stable natural system and a self-stabilizing market mechanism can lead to cyclical or even chaotic behaviour. A built-in self-stabilizing market mechanism will not always serve the function of stabilization. Under certain conditions, it may increase the amplitude of fluctuations and have the effect of destabilization, as demonstrated in this paper. Therefore, by incorporating a self-stabilizing market mechanism, this model yields a result that contradicts Solow's (1973) conjecture that the market mechanism will have the effect of smoothing the time path of the world economy. -- Hans Gottinger, 1998

The crucial difference between production and extraction is that the dynamics of scale in extractive economies function inversely to the dynamics of scale in the productive economies to which world trade connects them.

Rather than repeat what Bunker wrote, though, I'm going to cite, later, a longer piece by Nicholas Kaldor from his 1985 Hicks Lecture that makes a somewhat similar point. But first, I want to present some background on an old debate and a 'new' theory.

In December 1926, The Economic Journal published an article by Piero Sraffa dealing with "that difficult branch of economic theory" -- the theory of increasing returns. Over the next five years it published responses from Cecil Pigou, G. F. Shove, Lionel Robbins and Allyn Young and, in March 1930, a symposium on the topic by D. H. Robertson, Sraffa and Shrove.

Almost exactly 60 years later, in October 1986, The Journal of Political Economy, published Paul D. Romer's "Increasing Returns and Long-Run Growth," an important contribution to so-called New Growth Theory. Romer took his cue explicitly from Young's 1928 paper, "Increasing Returns and Economic Progress" and although he mentioned the precedents of Adam Smith's pin factory and Alfred Marshall's distinction between internal and external economies, he skipped over the rest of the debate in which Young's contribution had appeared.

Critics have argued that Romer's usage of increasing returns and external economies is not faithful to Young's formulation, in that it "overlooked Young's emphasis on the reciprocal relations between the division of labor and the feed-back into aggregate demand as a requirement for growth," "neglected Young's categorical rejection of the usefulness of Walrasian general equilibrium models" and wrested "Marshall's microeconomic concepts of internal and external economies out of his theory of value and price to serve as a basis for amending constant return production functions to exhibit increasing returns for the macroeconomy" (Rima 2004, 181-182).

My concern here is with a more conspicuous omission in Romer's analysis -- the distinction between increasing returns as characteristic of manufacturing and diminishing returns as dominant in agriculture and extractive industries (Young 1928, 528-529). The words "agriculture," "land" and "rent" do not appear in Romer's 1986 article. When Romer mentions diminishing returns, it is only in the context of research activity or the limiting assumptions of classical conventional growth models. But diminishing returns is a specific limitation, not a generality that can be indiscriminately "offset" by increasing returns. In a lecture given at Harvard in 1974, "What is Wrong with Economic Theory," Kaldor explained that "it is the income of the agricultural sector, (given the "terms of trade") that really determines the level and the rate of growth of industrial production, according to the formula:"

Or, in prose, economic growth depends on either a relative reduction in the income of agriculture or increased demand from agriculture for industrial products. And, of course, increased demand from agriculture implies increased agricultural production, which at some point confronts the problem of diminishing returns. In his 1985 Hicks Lecture, Kaldor explained the inverse dynamics of scale between industrial and agricultural areas, parenthetically, in terms of the "differing manner of operation of perfect and imperfect competition":

The basic requirement of continued economic growth is that the various complementary sectors expand in due relationship with each other -- that is to say that general expansion is not held up by "bottlenecks" in key sectors. However, in the course of time, under the influence of technical progress, both of the natural-resource saving and labour-saving kind, the requirements of expansion may become considerably modified. In the manufacturing sector which becomes more important as real incomes rise, there are considerable economies of scale, as a result of which manufacturing activities are subject to a "polarization process" -- they are likely to develop in a few successful centres, and their success has an inhibiting effect on similar developments in other areas. The realisation of these economies of scale normally requires also that numerous processes of production which are related to each other are carried out in close geographical proximity.

As a result different regions experience unequal rates of growth of output and of population. The industrial areas experience a growing demand for labour which may involve immigration from other areas once their own surplus labour is exhausted. Technological development in primary production on the other hand, tends to be more labour-saving than land-saving, so that the growth of output may go hand in hand with a falling demand for labour; and though output per head may grow fast in real terms, the level of wages will tend to remain low (and may even be falling) as a result of a growing surplus population. Since labour cost per unit of output is the most important factor in determining selling prices (at any rate under competitive conditions) the low wages prevailing, in terms of industrial products, will mean that the terms of trade will move unfavourably to primary producers, which may be the main factor, along with the low coefficient of labour utilisation, for their state of "under-development" characterised by low standards of living. The important contrast -- which I regard as a major factor in the growing inequality of incomes between rich and poor countries -- resides in the fact that the benefit of labour saving technical progress in the primary sector tends to get passed on to the consumers in the secondary sector in lower prices, whereas in the industrial sector its benefits are retained within the sector through higher wages and profits. (The main reason for this difference lies in the differing manner of operation of perfect and imperfect competition.)

Kaldor's parenthetical explanation suggests more than it reveals. Sraffa's 1926 discussion is the key to unpacking why Kaldor specifies perfect competition as characteristic of primary production and associates imperfect competition with manufacturing industry. The key determinants, in that view, are the shapes of the firms' supply curves (increasing or diminishing returns) and the nature of external economies.

Externality and Ecological Overshoot

Marshall's notion of "external economies" has gone through a series of modifications to become today's "externalities." Pigou extended the concept beyond Marshall's industrial agglomerations and distinguished between “incidental uncharged disservices” and "incidental uncompensated services." The former became known as negative externalities and the latter as positive externalities, although typically it is the negative environmental externalities that are referred to simply as externalities. There is a seeming but misleading symmetry to the two terms and a similarly illusory quality of reciprocity within each of them. When a disservice is uncharged or a service is uncompensated there is a presumption that there might otherwise have been a "whom" to charge or to compensate and that the missing invoice could have been denominated in currency. In other words, the charging and compensating would appear to be a financial transaction between two parties, both of whom must be assumed to be legal persons. In reality, the services or disservices performed may (or may not!) be extremely indirect and the parties affected incredibly diffuse, both in space and time. Mundane examples of factory soot and laundry hanging out to dry may be more mystification than illumination.

In the case of the external economies of increasing returns and diminishing returns, respectively, although they function inversely to one another it is a double inversion that ultimately produces parallel incentives to firms in manufacturing and agricultural or extractive industries. In other words, while firms in the manufacturing center are routinely considered to be the beneficiaries of external economies that generate increasing returns in the sense that they receive uncompensated services, firms in the extractive periphery may also benefit from the externalization of diminishing returns in that they are able to avoid being charged for the environmental disservices they inflict. In effect, the cost of diminishing returns is first displaced to poor regions where it is then deflected onto society and the environment. Unequal exchange thus takes place, that is to say, in the global external economies, "behind the back", so to speak, of formal monetary transactions.

Paul Romer’s eruption against mathiness has been quite a spectacle. Here you have an iconic name in modern economic theory throwing a fit in public, naming names (some of them also iconic) and denouncing his adversaries as enemies of scientific and ethical norms. It’s a bit over the top, a bit overdue and a bit underconsidered.

I want to focus on the underconsidered part. I was alerted to this aspect of Romer’s original paper by his sideswipes at Joan Robinson and the UK faction of the Cambridge capital controversy. Now, it happens that I take a middle position on this dispute: I think they were both in some sense wrong. The British Cantabrigians, along with their Italian comrades, were arguing from a model whose equilibrium assumption (equal rates of profit in all processes) is meaningless, in a mathiness sense, in an intertemporal context. (If you think Lucas rational expectations is a stretch, Sraffa rational expectations is even crazier.) But the MITers were also defending an aggregation of physical capital and its equivalence to a sum of financial capital that was also shown to be mathy—see here and here. Romer’s attack on Robinson was signaling that a double standard was at work.

In fact, economics is a veritable empire of mathiness. I agree with Romer that the use of algebraic entities that have no meaningful correspondence to real world objects and deliberate obfuscation through the use of words with multiple meanings are sins against science, but that is just the beginning. Here are two more, one theoretical, the other empirical:

1. Equilibrium with mechanisms. A large part of economic theory takes the form of equilibrium conditions and the comparative statics thereof. Even theories that describe events transpiring through time usually take the form of traversals: routes mapped from an initial equilibrium state to its successor. What usually goes missing are the mechanisms, the processes, in principle observable in the real world, by which actors revise their behavior and produce new collective outcomes. Without such mechanisms the concept of equilibrium is meaningless: you can’t get there from here. One symptom of this malady is the inability to distinguish between equilibrium conditions and identities—equal signs and identity signs. The difference is that causal processes apply to the first but not the second, so if your theoretical world lacks processes altogether you won’t know what that extra little line, ≡ vs =, is all about.

2. Misuse of null hypothesis significance testing. Suppose you have a theory that A causes B. You can’t observe this directly (or you haven’t bothered to try), but you can infer that, if this is true, a relationship between two measurable variables, an x and a y, will occur. So you do a study on x and y, run a significance test and conclude you can reject the null hypothesis that x and y are unrelated. And, if you are like most empirical economists, you will then announce that you have “tested” your theory about A and B and have found that the evidence is “consistent with” it. But wait! There are other theories that would also generate expectations on x and y and they may be inconsistent with yours. If the x-y business actually lends more support to one of these other theories than to yours, the evidence is saying the opposite of what you claim it says. The reality is that rejecting a null hypothesis says nothing at all about which of the many possible explanations for the non-null is correct. A conscientious empiricist would put all the potential theories on the table and consider in a systematic manner how the new evidence alters the relative credence we should give them. The reason utterly implausible theories live on, decade after decade, in economics is that low-bar implications—implications suggested by many theories of greater or lesser plausibility—survive significance testing and are then proclaimed “consistent with” the particular theory to which the researcher is attached. This too is a kind of mathiness: lots of fancy econometric technique wrapped around a dishonest and thoroughly unscientific core.

So I have mixed feelings about the Romer meltdown. I definitely understand where he’s coming from and how frustrating it is to see ideologues deploying math to obfuscate rather than clarify. But the problem is much wider and deeper than he seems to realize.

Monday, May 18, 2015

"I would like to say why I think that the Doomsday Models are bad science and therefore bad guides to public policy," -- Robert M. Solow, 1973

1973 was 42 years ago and 42 just happens to be the answer "to Life, the Universe and Everything," according to Deep Thought in Douglas Adams's Hitchhiker's Guide to the Galaxy. When challenged, the computer replied that he had "checked it very thoroughly and that quite definitely is the answer. I think the problem, to be quite honest with you, is that you’ve never actually known what the question is."

John Peet used that Deep Thought dialogue to frame his contribution to a 1997 forum, "Georgescu-Roegen versus Solow/Stiglitz." In his 1973 article, "Is the End of the World at Hand?" Solow framed his response to what he called the Doomsday Models with two questions, "You can ask: Is growth desirable? Or you can ask: Is growth possible?" "But..." as the title to Peet's commentary asked, "what is the real question?"

How about just plain old "What is growth?"? In his 1975 article, "Energy and Economic Myths," Georgescu-Roegen recalled that:

One confusion against which Joseph Schumpeter insistently admonished economists, is that between growth and development. There is growth when only the production per capita of current types of commodities increases, which naturally implies a growing depletion of equally accessible resources.

That is to say, if we are talking about growth, strictly speaking, then the depletion of resources is inherent in the process by definition. Solow's exposition of why he thought The Limits to Growth was bad science relied on blurring the distinction between qualitative development and quantitative growth and counting the former as an instance of the latter. This sort of legerdemain is, of course, standard in so-called growth economics.

Momentarily I will exhume and dissect the entrails of Solow's 1973 rebuttal to Limits but first a word from Geoff Tily, senior economist with the Trade Union Congress in the U.K. In a review of Diane Coyle's GDP: A Brief but Affectionate History, Tily argued that

...the development of national income accounting was as a means to an end, not as an end in its own right. The accounts were developed to support policy: to resolve the unemployment crisis of the Great Depression and to aid the deployment of national resources to their fullest possible extent for the conduct of the Second World War. The value of GDP, or rather at that stage ‘national income’, was of only slight interest.

Moreover, it is, I think, fundamental to recognise that these theoretical and practical initiatives were aimed at the level of activity – at the increased and then full employment of resources and the full extent of national production – rather than the growth of activity. At this stage there was no notion on the part of policymakers that the level of activity might be encouraged to grow in any systematic or uniform way from year to year; the intention was achieving one-off level shifts.

In summary, full employment and the effective deployment of national resources were the ends sought and national income accounting was seen as a means to those ends. "Growth" of national income had nothing to do with it. Eventually, growth became the goal -- even to the extent that full employment has come to be viewed as a dispensable side effect of growth that needs to be constrained to avoid accelerating inflation.

This targeting and exaltation of GDP growth was not something that Keynes had proposed. Pointing out that growth wasn't a "regular economic concept" before the war, Roy Harrod, one of the pioneers of growth theory, didn't "see how Keynes can have been expected to have systematic idea on growth; his systematic ideas related to full employment." (quoted by Tily)

So what is growth? Is it a means to the end of full employment? Is it a bait-and-switch surrogate policy objective in its own right? Is it a quantitative measurement of unmeasurable qualitative change? Those are not the questions Solow addressed in "Is the End of the World at Hand?"

The question Solow asked instead was whether the "basic assumption" made by Limits to Growth was any good. What was that basic assumption? According to Solow, the basic assumption of Limits to Growth was "that there are nobuilt-in mechanisms by which approaching exhaustion tends to turn off consumption gradually and in advance." No built-in mechanisms.

Rephrased positively, Solow was arguing that there are built-in mechanisms that will turn off consumption gradually and in advance. There are built-in mechanisms. There are built-in mechanisms. That is the answer: 42.

Lord Keynes took a different view in the BBC radio address in which he asked (and answered) the question, "Is the Economic System Self-Adjusting?" Keynes's answer, in a word, was "No." Of course Keynes was talking about employment, not the consumption of natural resources.

But wait... so was Solow! The core of Solow's argument was an analogy between labor productivity and natural resource productivity:

It is a commonplace that if you calculate the annual output of any production process. large or small, and divide it by the annual employment of labor, you get a ratio that is called the productivity of labor. ...

Symmetrically, though the usage is less common, one could just as well calculate the GNP per unit of some particular natural resource and call that the productivity of coal, or GNP per pound of vanadium. ...

Why shouldn't the productivity of most natural resources rise more or less steadily through time, like the productivity of labor?

After a brief discussion of productivity gains for various minerals -- or non-gains, "GNP per barrel of oil was about the same in 1970 as in 1951" -- Solow concluded:

So there is no really no reason why we should not think of the productivity of natural resources as increasing more or less exponentially over time.

But then the overshoot and collapse are no longer the inevitable trajectory of the world system, and the typical assumption-conclusion of the Doomsday Model falls by the wayside.

But Solow was not the first to compare the productivity of labor to the productivity of coal. Stanley Jevons did it a century earlier: "It is wholly a confusion of ideas," wrote Jevons in The Coal Question, "to suppose that the economical use of fuel is equivalent to a diminished consumption. The very contrary is the truth." He went on to explain:

As a rule, new modes of economy will lead to an increase of consumption according to a principle recognised in many parallel instances. The economy of labour effected by the introduction of new machinery throws labourers out of employment for the moment. But such is the increased demand for the cheapened products, that eventually the sphere of employment is greatly widened. Often the very labourers whose labour is saved find their more efficient labour more demanded than before.

So there you have it -- nothing to worry about, really. There is a built-in mechanism. The built-in mechanism will see to it that the economical use of natural resources will turn off consumption gradually and in advance lead to an increase in consumption. Well, er, pretend you didn't see that built-in mechanism...

Unpacking the tension between Solow, Keynes and Jevons, it would be safe to say that those "built-in mechanisms" don't always give exactly the results that would please us the most. There are feedback loops and then there are loops feeding back the feedback. The productivity of coal is connected to the productivity of labor in a way complementary to the way that full employment of labor is connected to the consumption of coal (or other natural resources). Either the built-in mechanism won't save us or, alternatively, there is no built-in mechanism. Select one from that menu.

To reprise Deep Thought's deep thought: "I think the problem, to be quite honest with you, is that you’ve never actually known what the question is."

As Greece lurches dramatically to its final economic showdown, there is an uncomfortable question that needs to be asked: is there an authoritarian grouping in the country whose seizure of power would be recognized and supported by its European “partners”?

It is absolutely clear at this point that a major objective of the current European leadership is to depose Syriza. But there is no democratic mechanism by which this can be accomplished. Assume an economic breakdown in which Greek savings accounts are wiped out. There will be mass discontent, but it will not be unanimous; many Greeks will see this cataclysm as a deliberate assault to humiliate and suppress them. Without new elections, which are still far off, there will be political upheaval but not regime change. This is where the Party of Order comes in, literally. If there is an alliance between segments of the military and a portion of the business class, it can suspend the constitution and install a new government. I expect that there are discussions in some circles right now about this possibility.

The first question is, who would step into this role? The second is, is any contact between them and key decision-makers in Europe currently taking place?

My personal view is that the old-school authoritarianism of the colonels (echoed in Golden Dawn) is not the primary threat, although I know nothing of the situation on the ground. I suspect Europe is more likely to support a liberal authoritarianism, one that gives lip service to personal freedom and enlightenment ideals. I can imagine some figures from the previous political establishment, backed by tanks, who call for peace, normalization and new elections.

If conversations along these lines are not ongoing, European policy is incoherent.

What should worry economists is the pattern, not any one of these papers. And our response. Why do we seem resigned to tolerating papers like this? What cumulative harm are they doing? -- Paul Romer

It is bracing to see the intense (dare I call it petulant?) indignation expressed by Paul Romer toward papers by McGrattan and Prescott, Lucas and Moll, and Boldrin and Levine. He goes so far as to confess "embarrassment" that his suggestions as discussant were acknowledged by McGrattan and Prescott in an earlier version of their paper. He complains of "a lemons equilibrium in the market for mathematical theory" and laments "years of being bullied by bad theory."

Economists detained after theory rumble between "Freshwater" and "Saltwater" gangs

Georgescu-Roegen was described in a critical note as "the methodological conscience of the profession for over a decade" whose mathematical renown rendered "his closely argued objections to the domination by mathematical methods... all the more welcome." In "Methods in Economic Science" (1979), Georgescu-Roegen wrote:

"According to the temper that has prevailed for some time now in the social sciences, but especially in economics, the contributions that deserve the highest praise are those using a heavy mathematical armamentarium; the heavier and the more esoteric, the more worthy of praise. Protests against this situation have not failed to be made sufficiently often to have deserved attention. What is more, protests of this kind were made not only by "verbal" economists, such as Thorstein Veblen and Frank H. Knight, but also by some who were well familiar with the mathematical tool, for example, Alfred Marshall, Knut Wicksell, and Lord Keynes. Knight lamented that there are many members of the economic profession who are "mathematicians first and economists afterwards." The situation since Knight’s time has become much worse. There are endeavors that now pass for the most desirable kind of economic contributions although they are just plain mathematical exercises, not only without any economic substance but also without mathematical value. Their authors are not something first and something else afterwards; they are neither mathematicians nor economists. How dangerous is the infatuation with pure mathematical symbolism is proved by the fact that voices from the circle of natural scientists have also often denounced it. ...

The fundamental reason why we cannot do without dialectical concepts is that actuality, at least as seen by the human mind, continuously changes qualitatively. …

The most we can expect from an arithmomorphic model is to depict pure growth, or rather pure quantitative variations of qualitatively different but self-identical elements.

In a 1981 commentary on Georgescu-Roegen's paper, Salim Rashid defended economists' persistence in undialectical methods as lying "not in their failure to appreciate the importance of dialectical logic, but in the institutional structure within which they live and work." To illustrate the utility of mathiness to career survival "at any reasonably good university," Rashid offered what he described as a "somewhat exaggerated" account of the "inimitable merits of mathematics" for facilitating "the process of grinding out articles." Furthermore, he maintained,

"...it is not the good mathematical economists or econometricians who insist upon the value of mathematical methods... The best users of mathematics can always move to a related field and do their research; it is the hordes of practitioners with lesser abilities who feel it essential to insist upon the value of mathematical methods."

By this account, then, the value of excessive mathiness was that it enabled mediocre junior faculty to survive and gain promotion in "any reasonably good university." In his reply to Rashid's commentary, Georgescu-Roegen asked, "Since publish or perish applies to all academe, why is it that economists alone can subsist by automatically grinding out empty exercises from the mathematical mechanism?" His answer was that "the American economics profession is dominated by a powerful and well-entrenched establishment determined to defend at all cost the type of economics by which virtually all its members climbed to the summit."

Romer lionizes Robert Solow and Gary Becker in contrast to Prescott, et al. In my opinion, Romer vastly overstates the cogency of Becker's contribution. As for Solow's growth theory, Georgescu-Roegen had a few things to say about that, too. In "Dynamic Models and Economic Growth" (1975), Georgescu-Roegen characterized Solow's model as one of "the most pertinent examples of the shortcomings of the mechanico-descriptive approach":

The economic literature of the last hundred years abounds in examples of this [mechanico-descriptive] category. The situation is the inevitable consequence of the mechanistic epistemology of our Neoclassical forefathers, who succeeded in convincing almost every subsequent economist that, if economics is to be a science at all, it must be set up as 'the mechanics of utility and self-interest'. We may mention, first of all, the picture of the economic process as a self-sustained circular movement between production and consumption (indifferently, between consumption and production) which adorns the most respected manuals. Perfect reversibility is present everywhere. It constitutes the main pillar of the theory of market equilibrium. According to the ultra-familiar picture, if demand shifts from D to D ', the market moves from E to E'; and should, later, the factor responsible for the shift disappear, the market would return to E, in a manner perfectly similar to that of a mechanical pendulum which can swing back and forth with equal ease. True, no economist has even suggested that a process of production may be reversed so as to convert pieces of furniture back into trees. However, the classical theory of business cycles -- as this traditional name indicates -- rests on the idea that the entire economic process may come back to any previous position by following the same path in reverse. We should also note that the entire theory of production is still based on the simple formula known as the production function, which is not a satisfactory description even of the reproducible process of production, i.e., of the simplest possible arrangement. But the most pertinent examples of the shortcomings of the mechanico-descriptive approach are the standard dynamic models beginning with that of Harrod and Domar and ending with those of Solow and Leontief. ...

…no analysis which, instead of assuming away the qualitative change associated with an actual process, focuses on that very change can attain its aim through an arithmomorphic model alone. The reason is that there is an irreducible incompatibility between qualitative change, i.e., between essential novelty, and arithmomorphic structures. It is this last point that shatters the generally accepted validity of the standard dynamic models as adequate representations of actual processes.

…mere growth -- i.e., change confined to quantity -- cannot exist in actuality continuously. The same is true even for the so-called stationary state. Briefly, continuous existence in a finite environment necessarily requires qualitative change. And it is this qualitative change that accounts for the irreversibility of the economic process, of any actual process for that matter.

Irreversibility and reversibility are the very properties that distinguish actual processes (which all are evolutionary in some sense or another) from those governed only by the laws of mechanics. We may therefore define a purely dynamic system as a system capable of returning to any of its previous positions. Certainly, all dynamic economic systems fulfil this condition: the fundamental notion behind dynamic economics is that investing and disinvesting, growth and contraction, are absolutely symmetrical operations.

Note that Georgescu-Roegen didn't exclude the "stationary state" from his critique. In a footnote, he singled out the fallacy of the Limits to Growth prescription: "Incidentally, this conclusion exposes the fallacy of those topical programmes which see the ecological salvation of mankind in a stationary state -- as the Club of Rome, for instance, does. See Donella Meadows et al." In "Energy and Economic Myths" (1975), however, Georgescu-Roegen noted the irony that Limits to Growth caused such consternation among economists -- "criticism of the report has come mainly from economists" (including Solow) -- apparently because it "employed analytical models of the kind used in econometrics and simulation works." What irked economists, in Georgescu-Roegen's view, was the intrusion on what they regarded as their turf:

Let us begin by recalling, first, that economists, especially during the last thirty years, have preached right and left that only mathematical models can serve the highest aims of their science. With the advent of the computer, the use of econometric models and simulation became a widespread routine. The fallacy of relying on arithmomorphic models to predict the march of history has been denounced occasionally with technical arguments. But all was in vain. Now, however, economists fault The Limits to Growth for that very sin and for seeking "an aura of scientific authority" through the use of the computer; some have gone so far as to impugn the use of mathematics. Let us observe, secondly, that aggregation has always been regarded as a mutilating yet inevitable procedure in macroeconomics, which thus greatly ignores structure. Nevertheless, economists now denounce the report for using an aggregative model. Thirdly, one common article of economic faith, known as the acceleration principle, is that output is proportional to capital stock. Yet some economists again have indicted the authors of The Limits for assuming (implicitly) that the same proportionality prevails for pollution — which is an output, too! Fourthly, the price complex has not prevented economists from developing and using models whose blueprints contain no prices explicitly — the static and dynamic Leontief models, the Harrod-Domar model, the Solow model, to cite some of the most famous ones. In spite of this, some critics (including Solow himself) have decried the value of The Limits on the sole ground that its model does not involve prices.

The final and most important point concerns the indisputable fact that, except for some isolated voices in the last few years, economists have always suffered from growthmania. Economic systems as well as economic plans have always been evaluated only in relation to their ability to sustain a great rate of economic growth. Economic plans, without a single exception, have been aimed at the highest possible rate of economic growth. The very theory of economic development is anchored solidly in exponential growth models. But when the authors of The Limits also used the assumption of exponential growth, the chorus of economists cried "foul!" This is all the more curious since some of the same critics concomitantly maintained that technology grows exponentially. Some, while admitting at long last that economic growth cannot continue forever at the present rate, suggested, however, that it could go on at some lower rates.

Friday, May 15, 2015

The US press is infamous for covering domestic politics largely in terms of “who’s ahead?” rather than “whose policies are in loose conformity with reality?” The same seems to go for its international economic coverage.

Today’s New York Times has a hit piece on Yanis Varoufakis, who it says has a “flair for inflaming the debate about his country’s economic future.” Inflaming or informing? Does it matter? Does anyone at the Times bother to ask?

Anyone who is paying attention to the eurozone situation knows that the driving force pushing Greece to the wall, in the immediate term, is the European Central Bank, which has been dripfeeding the Greek financial system, intensifying capital flight and all but guaranteeing a financial collapse—the Fahrenheit 451 of central bank firefighting outfits. Greece, of course, would have massive problems in any case, but the gun directly to its head belongs to the ECB.

Mario Draghi, the guy who would “do whatever it takes” to shore up the market for peripheral sovereign debt in the eurozone, has made an exception for Greece. His official justifications are transparently erroneous. Fear of suffering losses? It’s no different for Greece than Spain, Portugal or anyone else: if the ECB firmly backstops the market with its unlimited ability to buy bonds, no default is possible. It’s the same with any central bank that controls a currency in which the debt is denominated.

If the official reasons are wrong, what’s the real reason? This is where Varoufakis comes in. He says it’s because the German representatives to the ECB are holding Draghi hostage. I don’t know whether or not this is true; I’ve seen speculation to this effect, but whether it’s the story behind the story, or even a part of it, is unclear. Since Varoufakis has not tried to talk back his remarks, I assume he wants to spur public debate on the Bundesbank and its pressure on the ECB. Perhaps he thinks that there is a difference between that arm of the policy apparatus and the views of Merkel and Schäuble.

In its diatribe against Varoufakis, the Times article never stops to ask, is he right about the Bundesbank and ECB? Nor, of course, do they devote even a single word to the question of whether the ECB position on Greece is anything less than insane.

And as for the “convoluted scheme” suggested by Varoufakis, that Greece borrow from the European Stability Mechanism rather than the ECB, it’s no more convoluted than the current arrangement, and the apparent justification is political rather than economic—to reduce the direct pressure of the ECB on the day to day survival of the Greek financial system.

I’m reminded of an old saying: you point to a problem in the world and the press writes an article about your finger.

Thursday, May 14, 2015

Publication of Richard Thaler's Misbehaving has brought renewed attention to behavioral economics and to the "Libertarian Paternalism" advocated by Thaler and his co-author in their 2008 best-seller, NUDGE. In an earlier post, Libertarian Paternalism and the Pantomime of the Rational Actor, Sandwichman expressed deep reservations about the conceptual coherence of the LibPat argument. He compared the incongruous pastiche of rational choice and nudging to a parallel mash-up that occurred in Marxism, as criticized in the late 1940s by Harold Rosenberg.

My co-blogger, Barkley Rosser, claimed that my argument was "substantially the same" as the anti-paternalist libertarian case advanced by Mario Rizzo and Douglas Whitman. Having now read their "Little Brother Is Watching You: New Paternalism on the Slippery Slopes," I can affirm that I am "in league with" those authors' views when they write, "Our claim is not that slippery slopes are the only objection to the new paternalism." Beyond that, my main objections to LibPat are fundamentally different than Rizzo's and Whitman's. I part company with the latter authors at a point where they are still in consensus with Sunstein and Thaler.

Rizzo and Whitman state that their main problem with the libertarian paternalist framework is that "it defines freedom of choice (and libertarianism) in terms of costs of exit, without any attention to who imposes the costs and how [emphasis in original]." The go on to make it clear that they define choice as corresponding to property and personal rights and public policy as a coercive abridgement of those rights.

In other words, Rizzo and Whitman agree with Sunstein and Thaler's narrow framing of choice exclusively in terms of the cost of exit. This is essentially a marketplace definition of choice, as Albert Hirschman pointed out in Exit, Voice and Loyalty. Neither Sunstein and Thaler nor Rizzo and Whitman address the other element of choice: voice.

Turning to Hirschman's classic to borrow his definitions of exit and voice, I realized that Hirschman framed his discussion explicitly in terms of the misbehavior of economic agents. The following passage from the introduction to Exit, Voice and Loyalty proposes a much more satisfactory approach to the "misbehaving" of humans than does the technocratic framing fix of Nudge:

Under any economic, social, or political system, individuals, business firms, and organizations in general are subject to lapses from efficient, rational, law-abiding, virtuous, or otherwise functional behavior. No matter how well a society’s basic institutions are devised, failures of some actors to live up to the behavior which is expected of them are bound to occur, if only for all kinds of accidental reasons. Each society learns to live with a certain amount of such dysfunctional or misbehavior; but lest the misbehavior feed on itself and lead to general decay, society must be able to marshal from within itself forces which will make as many of the faltering actors as possible revert to the behavior required for its proper functioning. This book undertakes initially a reconnaissance of these forces as they operate in the economy; the concepts to be developed will, however, be found to be applicable not only to economic operators such as business firms, but to a wide variety of noneconomic organizations and situations.

While moralists and political scientists have been much concerned with rescuing individuals from immoral behavior, societies from corruption, and governments from decay, economists have paid little attention to repairable lapses of economic actors. There are two reasons for this neglect. First, in economics one assumes either fully and undeviatingly rational behavior or, at the very least, an unchanging level of rationality on the part of the economic actors. Deterioration of a firm’s performance may result from an adverse shift in supply and demand conditions while the willingness and ability of the firm to maximize profits (or growth rate or whatever) are unimpaired; but it could also reflect some “loss of maximizing aptitude or energy” with supply and demand factors being unchanged. The latter interpretation would immediately raise the question how the firm’s maximizing energy can be brought back up to par. But the usual interpretation is the former one; and in that case, the reversibility of changes in objective supply and demand conditions is much more in doubt. In other words, economists have typically assumed that a firm that falls behind (or gets ahead) does so “for a good reason”; the concept — central to this book — of a random and more or less easily “repairable lapse” has been alien to their reasoning.

The second cause of the economist’s unconcern about lapses is related to the first. In the traditional model of the competitive economy, recovery from any lapse is not really essential. As one firm loses out in the competitive struggle, its market share is taken up and its factors are hired by others, including newcomers; in the upshot, total resources may well be better allocated. With this picture in mind, the economist can afford to watch lapses of any one of his patients (such as business firms) with far greater equanimity than either the moralist who is convinced of the intrinsic worth of every one of his patients (individuals) or the political scientist whose patient (the state) is unique and irreplaceable.

Having accounted for the economist’s unconcern we can immediately question its justification: for the image of the economy as a fully competitive system where changes in the fortunes of individual firms are exclusively caused by basic shifts of comparative advantage is surely a defective representation of the real world. In the first place, there are the well-known, large realms of monopoly, oligopoly, and monopolistic competition: deterioration in performance of firms operating in that part of the economy could result in more or less permanent pockets of inefficiency and neglect; it must obviously be viewed with an alarm approaching that of the political scientist who sees his polity’s integrity being threatened by strife, corruption, or boredom. But even where vigorous competition prevails, unconcern with the possibility of restoring temporarily laggard firms to vigor is hardly justified. Precisely in sectors where there are large numbers of firms competing with one another in similar conditions, declines in the fortunes of individual firms are just as likely to be due to random, subjective factors that are reversible or remediable as to permanent adverse shifts in cost and demand conditions. In these circumstances, mechanisms of recuperation would play a most useful role in avoiding social losses as well as human hardship.

At this point, it will be interjected that such a mechanism of recuperation is readily available through competition itself. Is not competition supposed to keep a firm “on its toes”? And if the firm has already slipped, isn't it the experience of declining revenue and the threat of extinction through competition that will cause its managers to make a major effort to bring performance back up to where it should be?

There can be no doubt that competition is one major mechanism of recuperation. It will here be argued, however (1) that the implications of this particular function of competition have not been adequately spelled out and (2) that a major alternative mechanism can come into play either when the competitive mechanism is unavailable or as a complement to it.

Enter “Exit” and “Voice”

The argument to be presented starts with the firm producing saleable outputs for customers; but it will be found to be largely—and, at times, principally—applicable to organizations (such as voluntary associations, trade unions, or political parties) that provide services to their members without direct monetary counterpart. The performance of a firm or an organization is assumed to be subject to deterioration for unspecified, random causes which are neither so compelling nor so durable as to prevent a return to previous performance levels, provided managers direct their attention and energy to that task. The deterioration in performance is reflected most typically and generally, that is, for both firms and other organizations, in an absolute or comparative deterioration of the quality of the product or service provided. Management then finds out about its failings via two alternative routes:

(1) Some customers stop buying the firm’s products or some members leave the organization: this is the exit option. As a result, revenues drop, membership declines, and management is impelled to search for ways and means to correct whatever faults have led to exit.

(2) The firm’s customers or the organization’s members express their dissatisfaction directly to management or to some other authority to which management is sub ordinate or through general protest addressed to anyone who cares to listen: this is the voice option. As a result, management once again engages in a search for the causes and possible cures of customers’ and members’ dissatisfaction.